Why Prologis Can Handle an Industrial REIT Downturn

Shares of Prologis (NYSE:PLD) have fallen roughly 30% from their 2022 highs. That's a sizable drawdown that's pushed the dividend yield up to about 2.9%. While the yield has been higher in the past, it's been about middle of the road over the past decade. That suggests that the stock is at least fairly priced today, noting that the dividend has increased at a rapid annualized clip of 11% over the past 10 years. But what about that stock drop? And is the dividend safe?

What's really going on

Prologis' share-price decline is being driven by two broad factors. The first is the rise in interest rates. Real estate investment trusts (REITs) like Prologis are designed to pass income on to investors in the form of dividends. When rates rise other income choices start to look more attractive. For example, investors can probably find lower-risk investments like a certificate of deposit or a money market fund with yields that are higher than Prologis' right now. That puts downward pressure on REIT shares, increasing yields so that they remain competitive with other income options.

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Higher interest rates also increase costs for REITs as they look to finance their acquisitions. Essentially, it costs more to borrow. Over time, property prices tend to adjust for that, but it is not a quick process. So there can be some near-term pain for REITs when rates move quickly higher as they have of late.

The second reason for Prologis' decline is that there's been a shift in investor sentiment regarding industrial properties. That's particularly true of warehouses, which is the REIT's specialty. During the early days of the coronavirus pandemic, demand for warehouses skyrocketed thanks to an increase in online shopping by people socially distancing at home. As the world has opened back up, that demand has cooled off. Some high-profile retailers have chosen to reduce their growth plans with regard to warehouse space. And, thus, Wall Street has cooled on the warehouse space.

Not much to worry about

The thing is, Prologis' massive portfolio (a gargantuan 1.2 billion square feet across four continents) continues to perform at a high level. For example, first-quarter 2023 occupancy stood at 98%, and Prologis was able to push through 68.8% rent increases on expiring leases. Management believes this strength will continue in what it describes as a still tight warehouse market. In fact, the REIT slightly increased its core funds from operations (FFO) guidance for 2023, raising the low end of the range, when it reported earnings.

Moreover, the REIT's globally diversified portfolio is concentrated in key transportation hubs. These are areas where companies basically want, if not need, to be to ensure they have strong supply chains. That isn't to suggest that a broad downturn won't hurt the REIT, but that its portfolio is positioned to remain vital to customers in good economies and bad.

These two reasons alone suggest that Prologis' dividend is on solid footing. Notably, the company's core FFO payout ratio in the first quarter was a very reasonable 70% or so. That leaves plenty of room for adversity before a dividend cut would be on the table.

PLD Debt to Equity Ratio data by YCharts

And then there's the REIT's balance sheet. Although Prologis' debt-to-equity ratio isn't the absolute lowest in the industrial sector, at around 0.5 times it is among the lowest. That figure is quite reasonable even on a stand-alone basis. Looking at debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) shows a similar result. At roughly 3.9 times, Prologis' debt-to-EBITDA ratio is both reasonable and toward the low side of the range for the broader group.

Don't miss out

All in, Prologis' business is still performing well, it has a reasonable dividend payout ratio, and a strong balance sheet. Investor sentiment has shifted, as noted by the stock drop, for understandable reasons. But that could be an opportunity for investors in search of a well-positioned dividend growth stock trading at a reasonable price.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends EastGroup Properties, Prologis, Rexford Industrial Realty, Stag Industrial, and Terreno Realty. The Motley Fool has a disclosure policy.